Global safety rush sends U.S. yields plunging toward record lows

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Traders are preparing for the worst as the coronavirus spreads across national borders, stoking fears about its economic impact.

Investors snapped up U.S. Treasuries, sending the yield on 10-year securities plunging by as much as 11 basis points Monday to 1.36%, the lowest level since 2016 and within 5 basis points of its all-time low. The 10-year Treasury is the benchmark for the 30-year fixed-rate mortgage.

At 9:40 a.m. Eastern Time on Monday morning, the Dow Jones Industrial Average was down over 800 points.

Bets on Federal Reserve easing this year surged, with futures indicating a benchmark overnight rate of around 1% by year end. In Europe, the entirety of Germany's bond yield curve fell back below 0% for the first time since October, meaning that investors may have to pay for the privilege of holding them to maturity. Global stock indexes tumbled, with S&P 500 futures dropping 3%, the most in six months.

The total stock of negative-yielding investment-grade debt looked set to jump back above $14 trillion.

Other bond markets took a beating. Italy's debt appeared most vulnerable, with borrowing costs soaring above those of Greece's after the government imposed a lockdown on an area of 50,000 people near Milan, with infections in the country rising to about 150 from just a handful a week ago. The outbreak threatens to weigh further on the country’s already-struggling economy.

"The moves in bunds, Treasuries etc. are all rational moves, with the coronavirus now having a significant impact outside of China," said Peter Chatwell, the head of European rates strategy at Mizuho International Plc. "The impact on Italian bonds specifically seems extreme — this just goes to show that hotspots for the spread of the disease are being found a long way outside of China."

The spread of the coronavirus is quashing hopes that the peak rate of infections may have passed and bodes badly for the global economy, which had seen signs earlier this year of a rebound. As investors mark down growth estimates, expectations for rate cuts from the Federal Reserve have also gathered pace.

Rate cuts

Fed funds futures priced for two 25 basis point cuts this year, with the first fully priced for June. Money markets also moved to price in a full, 25-basis-point rate cut from the Bank of England in November, having previously not anticipated one for 2020.

Alessandro Tentori, chief investment officer at Axa Investment Managers, described a "triple whammy' for bonds, citing demand for safety, long-dated bonds and convexity-related pension flows. Swap spreads tightened once again in the U.S.

"The risk-off episode during the past 48 hours just adds to a global risk situation that's been deteriorating for months," Tentori wrote in a note to clients.

The U.S. 10-year yield has dropped more than 50 basis points this year. The all-time low is 1.318%, reached in 2016. The 30-year bond, typically favored in a risk-off environment, saw yields touch a record low on Monday.

The rate on its German and Dutch peers fell below 0% for the first time since October while Italy's 10-year yield jumped the most since December, reaching 1.0%, meaning borrowing costs at one point were higher than Greece's across the curve. Stock futures from Europe to the U.S. fell.

Yield curves flattened aggressively, with the premium between Germany's five-year bonds and 30-year ones closing in on the narrowest since 2008. Spanish benchmark securities are on their longest run of gains in a year.

Triple whammy

Cash trading was shut during the Asia trading session due to a holiday in Japan. The dollar once again proved itself to be the currency to own at times of stress, appreciating versus all Group-of-10 currencies with the exception of the yen. The latter’s appreciation showed its reputation as a haven outshining the growing recession risk in Japan.

To help model the effect of the virus, analysts are looking toward other major shocks, such as the terrorist attacks on the U.S. in 2001, or the global financial crisis. ADMacro is recommending investors target the bond markets of countries where central banks still have relatively high interest rates.

"Events are moving at speed and for all the bluster from central banks they have shown how quickly they can move when they have to — think 9/11. Think GFC (Global Financial Crisis)," wrote Patrick Perret-Green, head of research and strategy, in a note to clients. "The view is simple — look at the countries that have room to ease and where the pricing of such action is delayed. The U.S. and Canada are the stand outs and the U.K. is interesting."

Bloomberg News